Subject: Wiretap -- Vleeschhouwer's analysis of the 2Q 2009 EDA numbers

From: Jay Vleeschhouwer <jvleeschhouwer=user domain=earthlink got net>

Hi, John,

Here's my 2Q09 EDA industry overview.

The EDA industry has been declining for well over a year -- as seen again in
the most recent detailed data from the EDA Consortium (EDAC) -- as a result
of both external pressures on bookings and the revenue-recognition model
change at Cadence Design (CDNS).

For 2Q09, EDA revenues were $1.001 billion, down 15% (the sixth consecutive
quarterly decline), and trailing-twelve month revenues were $4.30 billion,
also down 15%.  At this point, based on current estimates for the largest
suppliers, we can estimate that EDA will be about $4.20-$4.25 billion, or
down about (8%-9%) from 2008, which was down 11%.  We've not previously seen
two back-to-back down years for EDA; on the other hand, perhaps industry
comparisons will start to flatten out by 1Q10.

License & maintenance revenues declined 14% in 2Q to $826 million, and for
the trailing twelve months by (18%) to $3.496 billion, the first time that
annual license & maintenance revenues have dropped below $4 billion since
the end of 2006 (and materially so, aided by the nearly half-billion dollar
in software revenues at Cadence over the twelve-months ended 2Q09).

The 2Q09 combined revenues of Cadence Design, Mentor Graphics, and Synopsys
of $738 million accounted for just under three-fourths of total revenues,
in keeping with their typical proportion of industry revenues.  Including
Magma Design, the main group of publicly-held EDA companies accounted for
$767 million, 77% of the industry, down 13%.

The next set of EDAC data, for the third quarter of 2009, will be compiled
after Magma Design, Mentor Graphics, and Synopsys report their results;
Cadence Design reported their results on October 28th (total revenues were
better than I had estimated, largely because of upside in maintenance
revenues, offsetting lower than expected product revenues, but their outlook
for the fourth quarter is somewhat less than I had been estimating).


EDA bookings for 2Q09

In 2Q09, the combined software bookings of the three largest suppliers was
about $445-$450 million, compared with about $525-$530 a year earlier; their
combined bookings were up modestly from 1Q09.

I foresee combined software bookings for the three largest EDA companies
this year of $1.98 billion (not including some recent small acquisitions),
down from about $2.12 billion in 2008, mostly due to what will be another
down year for CDNS -- for which, the estimated software-only bookings of
~$400 million may be less than those for Mentor Graphics in 2009 -- and what
appears to be a tough comparison in SNPS' 4QFY09 (MENT could be lower
year/year as well in 4Q, albeit up nicely from 3Q).  Including Magma's
bookings, the combined amount for 2009 could be about $2.1 billion vs. about
$2.2 billion in 2008.

The estimated software book/bill for Cadence this year is around 1.0x, or
perhaps slightly better, for Mentor ~1.0x, for Synopsys ~0.95x, and for
Magma also about ~1.0x.  The overall bookings outlook includes a shortening
of CDNS' average contract duration in 2009 (to a more normal 3 years or less
from what had been nearly 3 1/2 years on average in 2007-2008, a fairly
steady 3 years at SNPS, and the same for MENT.  Duration matters of course
in the context of considering run-rates, or average annual spending per year
per customer; suffice it to say that, in the aggregate, there's not been
much upward bias to run-rates of late).

CDNS's estimated 2010 software bookings of ~$600 million, while well above
the depressed 2008-2009 levels, would still be considerably less than the
prior several year annual average of about $1 billion, through, say 2007.

(In an unusual SEC filing after the 3Q earnings conference call, Cadence
noted that there had been an inadvertent disclosure that's its total 2010
bookings could be about $800 million or more; the implied $175-$200 million
increase over its 2009 forecast is consistent with what I would already have
assumed for next year.  In any event, Cadence has a long way to go to get
back to prior levels, and for the time being its bookings will be materially
less than Synopsys' are likely to be).  

Conversely, Synopsys' 2006-2010 average software bookings growth will likely
be higher (at about a mid-single-digit rate) than the low-single-digit
2000-2006 average, which was clearly slower than the peer group average at
the time; this has been offset along the way lately by the current cyclical
pressures -- but the underlying shift, or dichotomy of performance, is one
of the more important changes in the industry, in what could be called an
EDA competition pendulum.  These shifts in relative positioning can often
take years to manifest themselves (and to measure empirically), but such a
change has been underway.


EDA profitability for 2Q09:

For 2Q09, the composite non-GAAP operating profitability of the top three
companies was about $85 million, or about 12% of combined revenues (with
SNPS accounting for the bulk of those earnings) vs. $121 million a year
before.  Including Magma, the combined non-GAAP operating margin was still
about 12%, and for the trailing twelve-months, non-GAAP operating income
was about $122 million, or about 14% or revenues.  Prior to the downturn,
and the adverse effects on earnings by Cadence's model change, the leading
EDA suppliers had made progress towards improving composite operating
margins to the high-teens or better, which is a nominal level, at least,
for companies of this kind.

For the current year, combined non-GAAP operating profitability of the top
three could be about $340-$345 million, about 11% of revenue, vs. more than
$385 million last year, even with the respective cost-cutting measures
undertaken since the downturn began (note: "non-GAAP" is a method for
measuring earnings by excluding such items as amortization of intangible
assets, stock-based compensation, restructuring costs, and the like).  These
relatively low composite levels of profitability margins compare with
previous levels in the high teens or better (which is where companies of
this kind should typically be).


Vendor share for 2Q09:

As for vendors' share of total revenue, the quarterly results were:

 - Cadence Design had 21% of total industry revenues for the quarter, up
   slightly from 20% in 1Q09 but down from 26% a year ago.  This depressed
   share compares with the one-third or more average industry share it had
   up until a couple of years ago;

 - Magma had 3% share in 2Q09, and for the trailing twelve months, Magma's
   share was also 3%, as compared with the 4% average in recent years;

 - Mentor had 18% share in the quarter, up from 15% in the year ago quarter.
   Mentor's overall share for the trailing twelve months was 19%, up some
   from the 17% it averaged from 2005-2008 (the improvement most likely
   reflects continued strength in its Calibre franchise, small but important
   acquisitions, and a largely up-front revenue recognition model); and,

 - Synopsys had 34% of industry revenues in the quarter, a new high, up from
   29% in the year ago quarter.  Its share for the trailing-twelve months
   was 32%.  There is indeed underlying real improvement, but always bear in
   mind that for any given quarter or even year, revenue performance can be
   materially affected by license mix (upfront vs. subscription, or ratable)
   or where a vendor might be in terms of a license model transition (as
   Cadence is undergoing now).


EDA 2Q09 by geography:

In 2Q08, Japan and Europe both grew in the double digits year/year, while
North America and non-Japan Asia declined in the double-digits year/year.

In 2Q09, all regions declined in the double-digits year/year.


The North American vendor share for 2Q09:

 - Cadence's revenues of $100 million represented a 21% "share" in the
   quarter vs. 30% share in 2Q08 and 20% "share" in 1Q09.  For the trailing
   twelve months, Cadence had 20% share in North America vs. 33% in 2006
   and 2005.  From 2004-2007, Cadence's best regional share, on average,
   was in North America, followed closely by Japan;

 - Magma's revenues of $16 million in 2Q09 represented 3% of the North
   America market, up from 5% share in 2Q08.  For the trailing twelve
   months, Magma had 4% share in the region;

 - Mentor's $88 million in 2Q09 represented a 19% "share", up from an
   unusually low 12% share in 2Q08.  For the trailing twelve months,
   Mentor had 18% share in North America, somewhat better than in
   preceding years and,

 - Synopsys' revenue of $170 million represented 36% share in 2Q09, up from
   32% in 2Q08.  For the trailing twelve months, SNPS' share was 35%.

North America declined by 11% year/year to $468 million.  On a sequential
basis, North America was up 4% in 2Q09.  License & maintenance revenues were
down 7% year/year for the quarter to $392 million, and by 18% for the
trailing year to $1.57 billion.  North America still readily accounts for
the plurality, if not majority, of EDA spending.


Vendor shares in Europe for 2Q09:

 - Cadence's $45 million was a 23% "share", down from 28% in 2Q08, slightly
   above 1Q09's 26% share.  For the trailing twelve months, Cadence had 22%
   share in Europe;

 - Magma's $3 million was a 1% share, matching the 1% in 4Q08, and below
   the 2%-6% quarterly range over the preceding several years.  For the
   trailing twelve months, Magma had 2% share;

 - Mentor's $53 million was a 27% share.  Mentor's best market share has
   typically been in Europe.  For the trailing twelve months, Mentor's
   share in Europe was 28%, at least the equal of its 2007-2008 share; and,

 - Synopsys' $48 million represented 25% share, up from the 19% share in
   2Q08.  For the trailing twelve months, Synopsys had 23% share, an
   improvement from the 2004-2007 average.

In Europe, EDA was down 22% year/year, and down 3% sequentially, to $194
million.  For the trailing twelve months, Europe contributed $880 million,
down 15% from the preceding twelve month period.

License & maintenance revenues were down 21% year/year to $160 million.  For
the trailing twelve months, license & maintenance revenue was down 18% to
$717 million, as compared with $855 million in 2007, $753 million in 2006,
$690 million in 2005, and $680 million in 2004.


Japan's vendor share for 2Q09:

 - Cadence's $36 million, or 20% share, down from 20% share a year before.
   For the trailing twelve months as well Cadence had 20% share, as compared
   with an average of closer to 30% from 2004-2007;

 - Magma's Japan revenue was $4 million, for 2% share, unchanged from 2Q08;

 - Mentor's $26 million in 2Q09 represented an unusually low 9% share, as
   compared with their usual range of low-to-mid-teens share in Japan; and,

 - Synopsys' $66 million represented 37% share, a new high.  For the
   trailing year, Synopsys' share was 32% share, as compared with the
   low-20s share range from 2004-2007.

In Japan, EDA revenues were $178 million, down 22% year/year, and were down
substantially as well from the preceding quarter (some sequential decline is
not unusual for 1Q-2Q comparisons in Japan).  For the trailing twelve
months, revenue from Japan was down 20% to $823 million, as compared with
$989 million in 2007, $876 million in 2006, $860 million in 2005, $780
million in 2004, and $672 million in 2003.

License & maintenance revenues in Japan decreased 21% year/year to $149
million, which was also substantially lower sequentially.  For the trailing
year, license & maintenance revenues were $678 million, down 23%.


Rest of World vendor share for 2Q09:

 - Cadence had $30 million in RoW revenue in 2Q09, representing 19% share,
   down from 22% share in 2Q08.  For the trailing year too its share here
   was also 19%;

 - Magma's share was 5% in the region, somewhat better than in the other
   regions.  For the trailing year, its share was 3%, more or less the same
   as its 2004-2007 share;

 - Mentor's share was 16%, slightly better than a year before.  For the
   trailing year, its RoW share was 19%, better than its 2004-2007 average
   by a few points; and,

 - Synopsys had 39% share in RoW in 2Q09, here too a new high.  Share for
   the trailing year was 35%.

Finally, the "rest of world" was down 13% year/year to $160 million, and for
the trailing year RoW was down 6% to $672 million.  For much of the decade
to date, on average, RoW has been the fastest growing region for EDA, though
it has not avoided an occasional sharp deceleration, or, as we now see
lately, outright decline.


Product mix still matters:

While product category revenues can easily vary quarter to quarter, it is
still interesting to gauge category revenues over a period of several
quarters and years to see where design investments are trending.  Ideally,
an EDA vendor's portfolio will be aligned as much as possible to where the
growth in such spending is occurring or likely to occur.

Among the categories that appear to have been trending FLAT to HIGHER in
recent quarters are:

 - Hardware/software co-design & co-verification, or ESL (5% of revenues).
   This category, while down 13% for the quarter, was down only 6% for the
   trailing twelve months.  ESL is important to MENT;

 - RET EDA (8% of revenues).  Up 18% for the quarter, and up 12% for the
   trailing twelve month, owing to an unusually strong 1Q09.  This category,
   which generally has to do with yield enhancement is of particular
   long-term importance to each of the four largest EDA suppliers (MENT
   especially), plus smaller ones as well; and (somewhat surprisingly); and,

 - Synthesis (7% of revenues).  While the category has generally lost share
   of total spending over the past many years, it's held up reasonably well,
   with 2Q09 up sequentially and down only 3% year/year.  This category is
   of particular importance to SNPS, though it is unlikely to regain its old
   status as a long-term growth driver.

Among the categories that appear to be trending LOWER in recent quarters:

 - Physical implementation (i.e., place & route, floorplanning), is one of
   the larger EDA categories, accounting for 11% of revenues.  The category
   was down 22% for the quarter, to $109 million, and down 26% for the
   trailing twelve months.  The recent downtrend is a reversal of the
   positive trends we saw through 2007, though some of that prior momentum
   may have been attributable to the unusually large upfront revenues CDNS
   had been reporting through that time.  The recent declines can be
   correlated to the declines for CDNS' Digital IC Design segment, plus the
   decelerations in SNPS' "core" EDA segment.  For LAVA; if we infer that
   about two-thirds of its revenues are now in its traditional IC
   implementation segment (the remainder being several other newer segment
   initiatives), then we can infer that its revenue share in its main
   addressable segment is just under 20%, as compared with the one-fourth
   to one-third share inferred in previous years;

 - Analog/mixed-signal simulators (5% of industry revenues).  This product
   category, with $48 million, was down 9% for the quarter, a smaller
   decline less than the overall CAE (computer-aided engineering) group,
   but it was down 30% for the trailing twelve months.  This category is
   important to both CDNS and MENT; and the segment results do appear to
   correlate well to the declines in Cadence's Custom IC segment;

 - RTL simulation (8%).  Down 27% for the quarter to $78 million and 15% for
   the trailing twelve months.  This category matters to each of the largest
   vendors;

 - Printed circuit board (11% of industry revenues -- making it one of the
   largest but most unmentioned segments).  Down year/year to $106 million,
   down sequentially, and down 10% for the trailing twelve months.  MENT
   and CDNS are the principal domestic suppliers.  It appears the CDNS'
   "system interconnect" business was hit harder than the overall PCB
   category as reported by EDAC.  MENT's recently announced acquisition of
   Valor will bolster its share here, a key franchise for the company since
   inception in the 1980s;

 - Hardware-assisted verification (~5%).  In spite of an unusually strong
   sequential increase in 2Q09 from 1Q09, the category, dominated by MENT
   and CDNS, has slightly under-performed its overall EDAC category of CAE
   over the trailing twelve months.  CDNS appears to have the majority of
   product revenues here.

Cumulatively these LOWER categories outweigh the FLAT to HIGHER categories.

    - Jay Vleeschhouwer
      New York City, NY


  Editor's Note: Jay was the big dog amongst the EDA financial analysts
  before the Merrill Lynch meltdown that got absorbed by BofA.  - John